Balance of Payments Accounting

1. Balance of Payments Accounting

2. The Balance of Payments • Recall the open economy accounting identity: Income = Expenditures Y = C + I + G + NX • Trade Deficits imply NX< 0 Therefore, Y- (C + I + G) = NX < 0 Trade deficit countries are spending more than they earn (borrowing from the rest of the world)

3. Balance of Payments Accounting • Anything that we buy or sell to the rest of the world must be paid for. • The current account (CA) tracks the flow of goods and services between the US and the rest of the world • The capital & financial account tracks the payments for those goods & services (KFA) CA + KFA = 0

4. The Current Account • Any transaction that represents a flow of funds out of the US is represented by debit (-). Transactions that represent a flow of money into the US are represented by a credit(+) • Net Exports of Goods and Services Exports (+) Imports (-) • Net Income From Abroad (NFP) Income Earned by US nationals abroad (+) Income earned by foreign nationals in the US (-) • Net Unilateral Transfers Payments from foreign countries (+) Payments to foreign Countries (-)

5. The US Current Account: 2003 (in Millions of $s) Exports of Goods, Services, and Income Goods: $ 713,122 Services: $ 307,381 Income Receipts: Investment Receipts: $ 291,354 Employee Compensation: $ 3,031 Imports of Goods, Services and Income Goods: -$1,260,274 Services: -$ 256,337 Income Receipts: Investment Receipts: -$ 252,573 Employee Compensation: -$ 8,533 Net Unilateral Transfers: -$ 67,439 Current Account: -$530,668

6. US Exports

7. US Imports

8. The Capital & Financial Account • Again, any transaction that represents funds flowing into (out of) the US are credits (debits) in the KFA • Financial assets Foreign acquisition of US assets (+) US acquisition of foreign assets (-) • Official Reserve Assets Foreign acquisition of US reserve assets (+) US acquisition of foreign reserve assets (-)

9. The US Capital & Financial Account: 2003 (in Millions of $s) Capital Account: -$ 3,079 US Owned Assets Abroad (Increase/Financial Outflow (-)) US Official Reserve Assets: $ 1,523 US Government Assets: $ 537 US Private Assets: -$ 285,574 Foreign Owned Assets in the US (Increase/Financial inflow (+)) Foreign Official Assets in the US: $248,573 Foreign Private Assets in the US: $580,600 Capital And Financial Account: $542,680 CA + KFA = -$530,668 + $542,680 = -$12,012

10. Balance of Payments Accounting • Consider three transactions: • Wal-Mart buys $100M worth of clothing from a Chinese Manufacturer. Wal-Mart pays for the clothing by writing a check drawn off its account at Bank of America. • Warren Buffet collects $50M in interest payments from his financial investments overseas. The Payment is made by crediting Warren’s bank account in London. • Microsoft sells $20M worth of software to the French government. They pay in cash.

11. Current Account Exports Goods: Services: Imports Goods: Services: Net Factor Income: Net Unilateral Transfers: CA Balance: Capital & Financial Account Foreign acquisition of US assets: US Treasuries: Private Securities: FDI: Currency: US acquisition of foreign assets: FDI: Foreign Securities: Official Reserve Assets Foreign acquisition of US ORA: US acquisition of foreign ORA: KFA Balance: Balance of Payments Accounts $20M (3) $100M (1) -$100M (1) -$20M (3) $50 (2) -$50 (2) -$30M $30M

12. Tsunami Relief Aid • President Bush recently authorized $350M in aid for the Asian countries affected by the Tsunami. • This will appear in the BOP accounts under unilateral transfers. • Assume we pay this transfer in cash (most likely we would pay by check)

13. Current Account Exports Goods: Services: Imports Goods: Services: Net Factor Income: Net Unilateral Transfers: -$350M CA Balance:-$350M Capital & Financial Account Foreign acquisition of US assets: US Treasuries: Private Securities: FDI: Currency: $350M US acquisition of foreign assets: FDI: Portfolio Investment: Official Reserve Assets Foreign acquisition of US ORA: US acquisition of foreign ORA: KFA Balance: $350 Balance of Payments Accounts

14. US Balance of Payments

15. US Balance of Payments

16. US Balance of Payments

17. US Trade Weighted Exchange Rate Index

18. Balance of Payments and Exchange Rates • Should the Balance of Payments Accounts influence exchange rates? • A BOP deficit (surplus) indicates that financial assets flowing out of (into a) country. Shouldn’t that indicate a currency depreciation? • No really….the balance of payments is an accounting statement. Given the pattern of exchange rates, the BOP indicates the transactions that took place (Remember, by definition, BOP=0)

19. US Trade Accounts

20. US Official Reserve Position

21. US Official Reserve Position

22. US Foreign Investment

23. Foreign Investment in the US

24. The US BOP • Consider an alternative form of the national income accounting identity. Y = C + I + G + NX (Income = Expenditures) - Y = C + S + T (Income = Outlays) 0 = I + (G-T) + NX – S S = I + (G-T) + NX (Source of Funds = Use of Funds)

25. The US BOP • The US is running record trade deficits due to over consumption (US domestic savings is low and the government deficit is large) • Unlike past years, this trade deficit is NOT being financed by foreign private investment in the US, but rather by central banks purchasing US government debt…..this is potentially troubling!